Investment in Operating Working Capital

Your working capital (WC) is a difference between your current assets and current liabilities. I will cover WC in the section on financial ratios. Operating Working Capital is (no surprise here) the operating component of your WC.

On the asset side, it includes pretty much everything with the exclusion of prepaid expenses and ‘other’ current assets not related to your company operations; on the liabilities side, however, it includes only accounts payable and accruals directly caused by your operations. Thus excluding current portion of long-term-debt, short-term capital lease obligations, etc.

By definition, both asset and liability components of our OWC include only non-interest-bearing items (interest-bearing are a part of financing, not operating activities).

‘Investment in Operating Working Capital’ means that as your sales are recorded and reposted on your P&L on the accruals basis, some of them end up increasing your working capital (if not properly offset by appropriate current liabilities). And thus decreasing your cash flow. Which means that you have to subtract your Investment in Operating Working Capital from your Gross Cash Flow.

Your Investment in Operating Working Capital is, indeed, an investment. To maximize your sales (and thus your Gross Cash Flow) you must offer appropriate customer credit terms. Which result in inevitable increase in your OWC.

Therefore, your fundamental objective in managing your OWC is to optimize the latter to maximize the difference between your Gross Cash Flow and the increase in your OWC. Which, as usual, will require (1) solid methodology; (2) efficient business process; (3) efficient tools and (4) highly experienced and competent personnel.